The IRS recently instituted new reporting requirements for items with international tax relevance if you are a partnership (or LLC), s-corporation, or a US Person who is required to file Form 8865, Return of U.S. Persons With Respect to Certain Foreign Partnerships. Effective beginning for tax year 2021, the IRS is offering transition relief from certain penalties to give filers the time needed to be compliant with these new reporting requirements.
What is the impact of the new IRS reporting requirements?
Starting with tax year 2021, there will be two new Schedule K’s, Schedule K-2 and Schedule K-3, which will replace and supplement what used to be reported on the entity’s tax return itself and on line 16 (Form 1065 Sch K-1) or line 14 (Form 1120S Sch K-1), Foreign Transactions, on Schedule K-1. These new schedules are meant to give the partners and shareholders the information necessary from the entity to complete and file their individual tax returns with respect to international tax provisions.
Schedule K-1, which partners, members and shareholders receive at tax time for their distributive share of pass-through items from the entity will now be accompanied by the Schedule K-3, if there are items of international tax relevance. This schedule will also now contain the information necessary to figure their foreign tax credit. Schedule K-3 is meant to be an extension of the Schedule K-1.
Schedule K-2 is an extension of Schedule K, found on the tax return for each respective entity. Its purpose is to report items of international tax relevance from the operation of the business.
For Form 8865, for US persons who report foreign transactions and foreign partnership interests, Schedules K-2 and K-3, the changes are of the same type and nature.
The IRS has new instructions for these forms with guidance on how to provide international tax information.
How can businesses with foreign activity or partners comply with the new reporting requirements?
If you do not have any international activities or partners, you don’t need to do anything. For those that do, it would be a good idea to contact your tax advisor and let them know now. They can give you the help you need in regard to what you should do to keep track of the information you need to get from others: your partners, shareholders, or the CFP (controlled foreign partnership). The reporting on these new schedules is quite extensive and complex.
There is some good news, though. The IRS does realize that you might not have a plan in place to obtain information from your partners, shareholders, or the CFP and has provided transition relief for tax years that begin in 2021 in regard to the myriad of penalties that ensue should these forms not be filled correctly or submitted incomplete with a “good faith effort”.
A “good faith effort” means that you, the business owner, have made changes to your systems, processes, and procedures for collecting and processing all the information relevant to filing these new forms. The IRS will also consider if there were steps taken to modify the company’s corporate governance documents to facilitate the sharing of this information with the partners or shareholders. The IRS also expects you to collaborate with your partners in a partnership or LLC to identify the foreign related parties of each partner or member. In all cases, keeping an audit trail of your attempts and efforts would be a good way to document your “good faith efforts”.
Some of the key items to note for this new reporting requirement are:
- Foreign sourced passive income (cryptocurrencies may be a concern here)
- Foreign partners
- Domestic partners relations to foreign partnerships or corporations
- Foreign sourced personal property sales (think equipment, computers, tools, vehicles)
- Foreign taxes
- Downstream/upstream loans
- Other foreign sourced income and/or expenses
Our firm can help you avoid IRS penalties related to reporting foreign-based activities and partners.
The penalties that come with these new requirements are stiff. Some clocking in at $10,000 per instance. With the current transition relief, you have the opportunity now to fine tune this with your tax advisor so when the relief is gone, you are fully compliant.
The penalties that are included in this transition relief are:
- Failure to File or Show Information on Partnership Return
- Failure to File or Show Information on an S Corporation Return
- Failure to File Correct Information Returns
- Failure to Furnish Correct Payee Statements
- Failure to furnish information required by section 6038 (Form 8865 and each Sch K-1, K-2, & K-3)
You will want to note that part of a timely filed tax return for Forms 1065 and 1120S now includes Schedules K-1, K-2, and K-3.
International tax matters can be tricky. With the new reporting requirements for pass-through entities, it has become even stickier. While there is relief now from penalties, ignoring the issue until next year at tax time may be too late. It will be a lot easier to show good faith to the IRS if you try to get a handle on this during the tax year, not after. Reach out to our firm for professional help with issues related to foreign-based activities and partnerships.